100% Reserve Banking and the Business Cycle

[Paul.Bearer.of.Injustice]

There are three assumptions you make..
1. That the money supply should never grow.
2. That interest (or interest on interest) has to mean a growing supply on money.
3. That (exponential) credit creation will exceed human productivity growth.

1. No, I meant the money supply should increase with real wealth creation, not an arbitrary equation.
Let's invent another equation for the hell of it for interest, how about (1+x)^ex?

2. It has to unless outside forces act on it.. and I trust an equation more than someone's hope at trying to balance it

3. It's human nature to take more than you give... your arguments are purely academic but duly noted.

 

[ThePieSwindler]

1. No, I meant the money supply should increase with real wealth creation, not an arbitrary equation.
Let's invent another equation for the hell of it for interest, how about (1+x)^ex?

2. It has to unless outside forces act on it.. and I trust an equation more than someone's hope at trying to balance it

3. It's human nature to take more than you give... your arguments are purely academic but duly noted.

1. So then you're simply advocating a monetarist position. This is what Friedman advocated, like DriftWood said, the use of a computer. Gold is good because it can hold the money supply at a more constant rate, but its arbitrary -it can really be anything, so long as the money supply is expanded along with economic growth. This is what the Fed should do, if we are to have a Fed at all (lender of last resort is a good function of the Fed

2. DriftWood already addressed this, again, the risk/reward nature of money and financial systems helps smooth this issue. Theoretically it might be an issue in a simple system with a few variables, but in the real world, it works alot more smoothly because of the nature of markets. There are many problems, of course, but these are either problems created by government or by anomalies in the financial industry.

3. Psychologists/sociologist/anthropologists etc. might say its a bit more complex than that. Altruism and cooperation are just as much a part of human nature as self-interest. But of course, the problem with government is that it has perverted altruism into a coercive value. I'd argue that democracy is a vechicle for this form of coercive altruism, as well.

 

[Acala]

the subject is fractional reserve banking

A bank run of that sort could not happen in our modern system. People lost money in the depression because there was no facility to immediately convert credit money to notes. In today's world if a bank failed, their liabilities would just be transferred somewhere else or the Treasury would have to print it up..

The subject of discussion is fractional reserve banking. Fractional reserve banking is a fraud that creates a situation that has in the past caused people to lose their life savings overnight. You are correct that the government NOW covers for the banking fraud with fiat money, but that doesn't change the fundamental fact that fractional reserve banking is a fraud. Furthermore, in a serious economic downturn, while people may not lose their deposits because of Federal bailouts, they will be paid back with depreciated money.

Even the completely clueless people of the world assume that a bank loans out deposits. I don't know many people who believe that they have a vault full of cash ready to hand out to 100% of their customers.

Really? So you think the man on the street knows that most of the money in his checking account has been loaned out and would not be available on demand if other people happened to want theirs also? I think you are wrong.

In any event, fractional reserve banking causes the business cycle and the only purpose for it is to enrich bankers.

 

[DriftWood]

1. No, I meant the money supply should increase with real wealth creation, not an arbitrary equation.
Let's invent another equation for the hell of it for interest, how about (1+x)^ex?

2. It has to unless outside forces act on it.. and I trust an equation more than someone's hope at trying to balance it

3. It's human nature to take more than you give... your arguments are purely academic but duly noted.

Wealth is things like cows, houses, farmland, potatoes, etc. Its all the things in the world that people want. It is very hard to measure an increase in the supply of these things, floating around in the economy. Its also hard to measure and increase in the demand for these things in the economy. You need a good approximation, a good indicator of how much wealth is out there and how badly people want these things (how much energy they will spend to get one of these things). You need an equation that is a good approximation of the supply and demand for wealth, so you know when to turn on the printing press and when to reverse it. The price of gold is a pretty good reference point because its value is historically less volatile than other commodities (the demand and supply of gold does not change much).

You know that when the price of gold goes down it probably does not have much to do with the demand and supply of gold, it probably has more to do with a change in the the supply and demand of all other things. If the price of gold goes down, it probably because the economy has grown larger or more effective. The price of gold might not be a perfect measure in the short term (as there are extreme spikes sometimes), but in the long term it seems better than any other measure.

Yes, it is human nature to want to take more than to give.. but the fact is that noone can borrow more money that is not voluntarily lent to them by someone else.. keeps the giving and taking of money level. If you borrow money from me and blow it on Vegas instead of invest it (like you promised).. then i will have lost my money, and i will not lend you any more money in the future. Thats how excessive credit creation is kept in line with actual human productivity. No money or inflation is created from people lending and borrowing money to banks or each other.

Banks and credit creation really has nothing to do with inflation.. only the central bank is responsible for the money supply and therefore inflation.

Cheers

 

[taotree]

For one, its important to make a distinction between the two types of money. Base money (the stuff that FED creates) and Credit (the stuff that banks create). Credit is really not money at all (its the promise by a borrower to pay back the lender the money later). Any credit creation, will in the end have to be paid back in real money. So in the end all credit that is created, will be uncreated. I think most confusion about fractional reserve banking, inflation, fed etc comes from calling credit money.

So, what we're saying is that the money in a bank account is not base money, it is units of credit. However, you cannot separate the two completely because at any time, any and all depositors (except time deposits that we'll ignore for now) can convert that credit into base money. I'm assuming that physical cash is base money, is that incorrect?

Therefore, if all that "credit" is convertible on demand to money... it just about might as well be money. Also, as policies have changed over the years (last 200 or so), it has allowed more and more credit by requiring less reserves, thus resulting in a larger and larger total amount of "credit" out there.

I can lend you $100, you can lend that $100 to your mom, she can lend it to her friend and eventually everyone in the world will have lent that 100 to someone else.. everyone in the world will hold a 100 IOU credit note, to a total amount of a gazillion... however at the end there is only one person that actually gets to spend that 100 dollars.. after he spent it, he makes some money and pays it back to the person he lent it from.. and the person he lent it from will pay back it back again, until everyone in the world has payed back that 100.. and you finally pay back that 100 to me. And that gazillion in credit has shrunk back to zero.

But I think this example does not accurately reflect the banking situation. Because what you suggest would be fine and that would be 100% reserve banking. Because once I loan my mom $100, I can no longer access that $100. And when she lends it to a friend, she can no longer access it. In your description, at ALL times there is only $100 available to circulate. But the banking situation is different. When I "loan", aka deposit, my $100 to the bank, I can still get it out any time I want. And then the bank loans out that $100 to another person who then "loans" it back to the bank. The bank then lends it out to someone else, etc... but the problem is that every single person still has immediate access to all that "credit". Thus, in the bank situation, there really is a great deal more "credit" available to circulate than the base money. So... for example, if I write you a check, what I'm really doing in effect is authorizing the bank to transfer X credit from my account and put it into your account? There's no real money involved at all?

In other words, sure, it's credit and not "real money". However, it spends just like money. So, for the economy at large, there are many more units circulating than there is base money. And... in general, that means that we're not paying money for anything--all we're doing is transferring debt around.

The portion between credit and money does not matter. There is no correlation. All that matters is that the loans will be repaid. (As long as there are people with profitable use for money, there will be willing lenders.)

Well... is physical cash base money? If so, and thus credit is convertible to base money on demand, then the proportion would matter because that would determine how easy it is to cause a "run on the bank". If there is only $100 base money and $1 billion in credits, as soon as someone comes along and wants $200 cash, that doesn't work.

 

[DriftWood]

So, what we're saying is that the money in a bank account is not base money, it is units of credit. However, you cannot separate the two completely because at any time, any and all depositors (except time deposits that we'll ignore for now) can convert that credit into base money. I'm assuming that physical cash is base money, is that incorrect?

Therefore, if all that "credit" is convertible on demand to money... it just about might as well be money. Also, as policies have changed over the years (last 200 or so), it has allowed more and more credit by requiring less reserves, thus resulting in a larger and larger total amount of "credit" out there.




But I think this example does not accurately reflect the banking situation. Because what you suggest would be fine and that would be 100% reserve banking. Because once I loan my mom $100, I can no longer access that $100. And when she lends it to a friend, she can no longer access it. In your description, at ALL times there is only $100 available to circulate. But the banking situation is different. When I "loan", aka deposit, my $100 to the bank, I can still get it out any time I want. And then the bank loans out that $100 to another person who then "loans" it back to the bank. The bank then lends it out to someone else, etc... but the problem is that every single person still has immediate access to all that "credit". Thus, in the bank situation, there really is a great deal more "credit" available to circulate than the base money. So... for example, if I write you a check, what I'm really doing in effect is authorizing the bank to transfer X credit from my account and put it into your account? There's no real money involved at all?

In other words, sure, it's credit and not "real money". However, it spends just like money. So, for the economy at large, there are many more units circulating than there is base money. And... in general, that means that we're not paying money for anything--all we're doing is transferring debt around.




Well... is physical cash base money? If so, and thus credit is convertible to base money on demand, then the proportion would matter because that would determine how easy it is to cause a "run on the bank". If there is only $100 base money and $1 billion in credits, as soon as someone comes along and wants $200 cash, that doesn't work.

A quick reply (i hope)

Yes base money, the things that the fed creates is coins, notes and electronic bank reserves. All the thing that fed creates out of "thin air".

Credit or the note that says "Thanks man for the loan. I'll pay you back later, and a bit for your trouble. Promise". Its not money. At some point your friend is going to pay it back. Or if he forgets you are going to demand it back. He will give you the money and you will give him that credit IOU note, which he destroys. You would have a hard time, if you tried to go to the shop and buy something with that IOU note. The shopkeeper does not trust you or your friend. You will have to come back once you have real money.

Same goes for the bank, once you put your money it a account, it is lent back the back door and you are left with a note that says "Thanks man, I'll pay you back later". Someone already spent your money. You cant buy anything with that IOU note. What you can do is tell the bank that you want your money back now. And they say "Okay, hold on one sec. Here you go". The reason why they are able to do that is because they say to all their borrowers. "Hey, you remember that money i lent you. Well im a bit short at the moment so i need a bit of it back. Don't worry you don't have to pay back the whole thing, but just a little."

Such a bank has little or no reserves at all. All the money it ever lent from people it loaned out. Its a bank with zero or only a couple of percentages in reserves or in its vaults. The bank has no use for keeping much money in its vaults. They would just gather dust there, as lenders as a whole rarely take out all their money.

Fractional banking is the method that allows banks to connect short term lenders with long term borrowers. It works because as a whole all those short term lenders behave as one long term lender. Statistically short term lenders more often keep their money in the bank, rather than demand it out. How much money do you have in the wallet right now, compared to in your bank account. I bet you have more in the bank than in the wallet. Thats the kind of human behavior that make fractional reserve banking work.

Edit: I avoided the question a bit, about credit being used as money. In the case of the credit IOU note that is created when you loan money to a freind directly, few businesses will take that as payment. Some might. Maybe you, your friend, or your friends friend has a shop. And they will accept that IOU credit note. If they do, your friend will not pay you, but the shop owner the money back. So still no new money has been created.

The same should go for the credit that is created when you loan money to a borrower, thru the bank. Theoretically the bank could print IOU credit money with the banks logo.. with a text saying "This is proof of a $100 deposit. The bank promises to pay the holder of this note $100 back on request." (some banks in Northern Ireland does this). When you put money into your bank account, the bank would lend out that money and give your IOU credit note. You could take that IOU credit note and try buy something in the shop. The shopkeeper might tell you to come back with real money, or he might trust the bank to keep the promise, he might even have an account with the same bank. You could then buy something with that note, but no new money was created. Why? because now you will not get the real money back that you put into the bank account in the first place, rememver you gave away the certificate, the IOU credit note. The shopkeeper now has it, and he will get back the money that you lent out to the borrower that spent your money in the first place.. Hope that makes sense.

Cheers